What is CAGR (Compound Annual Growth Rate)?

by Amandeep Singh

in Stocks Market Dictionary

Compound Annual Growth Rate (CAGR) is one of those typical investing technical terms that we are unable to understand until somebody quotes an example for us. It?s a bit strange because the explanation undermines the simplicity of the calculation of the growth rate in question. 🙂

Simply put, CAGR is the the fixed rate of return that will give you the exact same growth of the investment that is being talked about. Let me explaing this by taking a simple example:

A portfolio with Rs. 10,000 becomes Rs.12,000 by year one, Rs.15,000 by year two, and Rs.25,000 by year three. The CAGR is simply 0.3572, or in other words, the portfolio enjoyed a 35.72% return annually.

Below is the formula so that you can calculate CAGR on your own without any hassle:

CAGR = ((ending value / beginning value) ^ 1/compound period)) ? 1

Where CAGR is Used?
This growth rate is used often when comparing growth of two entities because this measure reduces the effects of volatility. It is also used in business to report on a specific part of its operations, like revenue, subscriber growth etc.

What This Means to Us?
With the information about CAGR, you can easily compare two different investments? historic returns. Also, it is a great tool to use in calculating your own portfolio returns to see how fast it?s growing.

In your own investment portfolio, remember though that you have most likely made deposits or withdrawal. Therefore, don?t be alarmed when you see a 80% CAGR and do not falsely believe in your investment genius!

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